U.S. Supreme Court Expands Rights of States to Collect Tax on Internet Transactions

U.S. Supreme Court Expands Rights of States to Collect Tax on Internet Transactions

Since the dawn of the Internet, online sellers have benefited from a line of United States Supreme Court precedent that prevented states from requiring out-of-state businesses to collect and remit sales tax on sales in states where the seller has no “physical presence.”

On June 21, 2018, the Court discarded its longstanding “physical presence” test, thus opening the door for state governments to impose a broader range of duties on remote sellers, including the duty to collect and remit sales tax.

In South Dakota v. Wayfair, Inc., South Dakota sought to defend its statute that imposed a duty on all retailers with more than $100,000 of sales or 200 transactions within the state to collect sales tax on transactions and remit the tax to the state. For retailers with no physical presence in the state, the statute was clearly in violation of the historic interpretation of the Commerce Clause of the United States Constitution, which limits the ability of states to regulate “interstate commerce” unless there is a “substantial nexus” between the state’s interests and the commercial activity.

Prior court decisions concluded that a state could have no “substantial nexus” with a seller that had no “physical presence” in said state. As a result, online sellers with no “brick-and-mortar” presence or employees working in a state were free from the obligation to collect tax on their sales.

In South Dakota v. Wayfair, the Court rejected its prior interpretations of the Commerce Clause and held that a “substantial nexus” could be created by online sales alone despite the lack of “physical presence.” The decision was decided with a bare 5-4 majority.

As a practical matter, the majority of online sales already entail the collection of sales tax due to either requirements that were valid under prior law or voluntary compliance by larger online retailers (including amazon.com). Some retailers with no physical stores, however, will lose the advantage of being able to undertake transactions without collecting tax (including the respondents in the case, wayfair.com, overstock.com and newegg.com).

It will be up to each state to set the parameters of which remote sellers might be exempt from collecting tax due to a lack of significant sales, and the Court did not set a constitutional standard for what level of sales would constitute a sufficient “substantial nexus” to allow a state to impose duties (only that South Dakota’s standards were more than sufficient).

Perhaps more importantly, by jettisoning the “physical presence” standard as inappropriate in an era of “substantial virtual connections,” the Court has raised the prospect of greater opportunity for individual states to tax and regulate the actions of businesses whose only connection to said state is via online presence.

All businesses that connect with customers in other states via online connections will need to have heightened awareness that state tax and regulatory requirements in those other states may now apply to those interactions due to the Court’s new reading of the scope of a state’s authority under the Commerce Clause.